Forex Futures vs Spot Forex

There are some people who claim that forex futures contracts are “better” than trading the spot forex market.

Let me break down these arguments.

They claim that futures contracts are traded on a centralized exchange vs spot forex which is not on a centralized exchange. Then they talk about how with forex different brokers can offer different pricing since there is no centralized, regulated exchange. Then they talk about how retail forex brokers can shade prices or widen them during the news. Some may even talk about retail forex brokers “stop hunting.”

It is true that spot forex is decentralized. It is true that spot forex pricing can be different across brokers. It is true that retail forex brokers can shade prices. It is true that forex brokers can widen spreads during news.

But the truth is illiquidity and widening of spreads can easily happen on a futures contract as well. Widening of spreads is not just limited to spot forex. Widening of spreads is typically associated and related to the fact that the market is illiquid and buyers and sellers are difficult to find. It is true that some retail forex brokers widen spreads during news above and beyond what is normal and keep them elevated for an extended period of time after certain news releases. I have seen it happen.

If that is the case then you don’t trade with that broker, or you can trade with that broker, just organize your strategy around avoiding such situations.

As a general rule the people who advocate forex futures are usually scalpers, or super fast traders that are just looking to grab a few tics from the market. If you are such a trader, then forex futures can be better for you since you may be able to get better spreads and more consistent pricing. There are a lot of arbitrage and scalpers in the forex futures markets.

In reality, the most money isn’t made from scalping or from arbitraging pricing on different platforms. The big money and most money is made from global macro trading.

A scalper may be trying to make 5 or 10 tics on the Eurofx futures contract. I don’t care about such movements. I care about catching the next 50 pip or 100 pip move in the EUR/USD spot market. I know that will make me far more money than trying to scalp a few tics off a futures contract. There is almost much more room for liquidity if you are capturing a 100 pip move as opposed to a 5 pip move.

Who cares if pricing is off by a tenth of a pip here, or half a pip there between different forex brokers. If you are scalping for 5 or 10 pips, then you may care about those things. But if you are looking for 50 pip or 100 pip or 500 pip trades, then you don’t care about that price discrepancy. Let the arbitrageurs and quant funds try to grab that tenth of a pip or half a pip between platforms.

When I make a 100 pip profit on a EUR/USD trade, I don’t care if I got a tenth of a pip or half a pip worse price on the entry and exit. Sure I would of liked to have gotten the best possible pricing, but I am not going to be a dick for a tic. I am not going to focus my efforts and energy on such problems. Instead I am going to worry about how to catch the next 100 pip or 500 pip move. I know that is going to make me far more money than trying to scalp 5 or 10 tics off the market.

As for forex brokers stop hunting, they don’t do that. They don’t have the capital available to do that.

Forex futures also is limited in how you can express trade ideas and macro views. There are not that many liquid currency futures contracts. With spot forex you can express a trade idea and macro view using the strongest and weakest currency that you believe in. If you believe the AUD is going to be the strongest and the JPY the weakest, then you can play it in AUD/JPY no problem. If you believe the EUR is going to be weakest and CAD the strongest, then you can express that view in EUR/CAD no problem. With currency futures, it is not that easy.

When Soros broke the Bank of England, he didn’t use futures contracts. He used the spot forex market. He sold a few billions worth of pounds and converted them into Deutsche Marks. I am sure that the pricing between various dealers in the spot forex market was off by a few pips. The pricing may have even been off by 5 pips or 10 pips or more between various forex dealers. He didn’t care about that. He was just looking for anyone to take the other side of his pound short trade. He wasn’t focused on the few pip price discrepancy between brokers. That was the last thing on his mind. He was focused on the global macro move.

Similarly I don’t focus on a tenth of a pip or one or 2 pip price difference between brokers. Instead I focus on capturing the next big global macro move.

Soros could of never amassed a $10 billion short position in currency futures contracts. It would of been impossible. There was no liquidity available for that. Instead he focused on the inefficiency and liquidity available in the spot forex market to express his trade idea and macro view and profited handsomely.

The spot forex markets today are just as inefficient as they were back in 1992, with much more liquidity to boot.

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8 Responses to Forex Futures vs Spot Forex

Redbaron1981November 29, 2011

Very nice article GRKFX.
There are not that many articles that talk of liquidity around the net. If you have the mindset of what do big traders need to be able to trade Liquidity is high on the agenda. Yet it never seems to be mentioned anywhere on the forums.
Know where the liquidity is and you may find yourself brushing shoulders with some of the big guys....

how would order flow & news trading traded the decision by the 6 central banks to help the euro zone? the moment it was announced the markets turned 180 degrees- many traders were short on eurusd and they got hit.

I know it may sound simple and after the fact, but there wasn't a strong reason to be short eur/usd. Especially no reason to be short using a small stop and high leverage.
If you were highly leveraged with a small stop short eur/usd, then you could of gotten slipped and suffered big losses.
If you were lightly short eur/usd with small leverage and a bigger stop, then you just took a small loss.

There was some very strong buying taking place around 11am GMT time on the aussie and euro prior to the big break out before NY session around 8am bias was definately heading north also anyime there are massive amounts of longs or shorts int he market there is strong risk of a major reversal from any fresh peice of info its obvius those on the inside new and repositioned themselves quickly i think there are some plays you just cant catch unless your in already or re position in time, you cant know this would happen unless your on the inside and can execute right away when given the greenlight. anyone else have another take pls share. Thanks

"As for forex brokers stop hunting, they don’t do that. They don’t have the capital available to do that."
Well Grkfx......There are very bad brokers that hit customer stops via feed manipulation too and for that they don't need capital. However, if any retail trader has done their homework they would surely be able to avoid such brokers and go for the better retail brokers out there.

Too much talking about the pips.
It is all about the R(isk) and it multiples. You are trying to capture 100 pip moves but by what kind of risk (stop loss placement) ?
Someone who is capturing 10 pip moves with 3 pip stops is much better than a guy trying 100 pips with 50 pip stops.
Then comes the frequency. You have to wait opportunity to catch that 1:2 trade much longer than a guy who have 10 pip moves 10-20 times / day with the outcome of 1:3.3
When you compare markets relatively (on the risk) the choppiness is very same regardelss are you trading 10 second charts or 1 hour charts (bar size). This is a thing which is not understood right by many traders even experinced ones.
I get much better fills in futures because of "regulated" (exchange rules) and centralized order matching. This is why I use futures. Side product: accurate volume data.
btw. Of course the liquidity may be the issue but then you have to be BIG and try to trade outside of the EU and US sessions.

You are right that it is all about risk and risk multiples.
Although there is one additional element to consider if someone is trying to capture 10 pip moves using 3 pip stop losses. That element is the spread to profit ratio. If someone is grabbing 10 pip profits, and pays a 1 pip spread, then the spread is 10% of the potential profit. On the other hand, someone who is grabbing 100 pips and pays a 1 pip spread, then the spread is only 1% of the potential profit.
Also there is the factor of market "noise" which can take you out of a trade prematurely. The person trading with a 3 pip stop is going to get stopped out much more by the market noise than someone with a larger stop loss.
Of course it all still depends on the reward risk ratio like you said, but also on what type of trading you are engaging in. There may be some high frequency rapid fire traders that like to try to capture ultra tiny pip movements.

That is correct. By using tight stops it is more expensive but also think about the frequency. I am able to pay some extra to my broker if I can trade 50 positions per day than only 1 or 2. Risk/trade is still equal.
There is an edge in higher time frames: sudden price moves does not hurt you so much. Definitely you have to be out of your positions when there is some bigger important news coming out. The possibility of suprise news makes it more riskier to trade lower time frames. Of course nothing is 100% fail safe.
That noise thing I do not agree. As I said this issue is misunderstood by many traders. It is little a bit difficult to explain shortly (with my bad english ;). When you look your positions from the view of risk the level of noise is quite equal are you trading 1 day or 1 minute charts. The killer thing (for direction or another) is the frequency. This would need more and some charts examples to explain better...
Anyway thank you very much for your blog and comments.